Technical Trading Guide

1. Chart the Trends and Range Bound Markets

 

Use long term charts to decide trends or range bound markets. Begin a chart analysis with daily, weekly and even monthly charts spanning several years if possible. A larger scale chart essentially shows the life of the market and provides clearer visibility and a better long-term perspective on a market. Once the long-term has been established, consult daily and intra-day charts, these charts can include anything from say 10 minute to daily charts. A short-term market view alone can often be deceptive. Even if you only trade the very short term, you will do better if you're trading in the same direction as the intermediate and longer-term trends. If there is no trend then a different strategy is necessary, possibly playing the range until the market begins to trend once more.
As can be seen in the 1-hour EUR/USD candle chart below there has been an uptrend with three peaks and three troughs. Long entry positions would at 1.2700, 1.2760 and 1.2800.


2. Follow the Trend

If you determine the trend, then follow it. Market trends come in a variety of terms - long-term, intermediate-term and short-term. The first thing you have to determine is what type of a trader are you, long term or day trader, that decision will determine which charts you should be using. For instance, if you're day trading, use the daily and intra-day charts, but always use the longer-range chart to determine the trend, and then use the shorter-term chart for timing. Make sure you trade in the direction of that trend and then buy on dips if the trend is up and sell on rallies if the trend is down.

3. Locate Support and Resistance Levels

Find the support and resistance levels. As above when you want to buy an instrument, its best to buy near support levels. The support is usually a previous reaction low. Using the same logic, the best place to sell an instrument would be near its resistance levels. The resistance level is usually a previous peak. After a resistance peak has been broken, it will usually provide support on subsequent pullbacks. In other words, the old high becomes the new low. In the same way, when a support level has been broken, it will usually produce selling on subsequent rallies - the old low can then become the new high.

4. Retracements

Measure retracements in percentage terms. Market corrections up or down often retrace a significant portion of the previous trend. One can measure the corrections in an existing trend in simple percentages. A fifty percent retracement of a prior trend is most common. A minimum retracement is usually one-third of the prior trend. The maximum retracement is usually two-thirds. Fibonacci retracements of 38% and 62% are also worth watching. Therefore popular buy points in an uptrend are usually between 33-38% retracement of the original trend.
As can be seen from the chart below, when joining the trough at 1.2750 to the peak at 1.2890 in the 1-hour EUR/USD chart we can see the Fibonacci levels drawn out. The first retracement ended at the 38% line and the major retracement at the 62% line.

5. Trend Lines

One of the simplest and most effective charting tools are trend lines – use them. Draw a straight line that join two points on the chart. Up trend lines are drawn along two successive lows and down trend lines are drawn along two successive peaks. Prices will often pull back to trend lines before resuming their trend. The breaking of trend lines often signals a change in a trend. The longer a trend line has been in effect, and the more times it has been tested, the more significant it becomes; a trend line becomes valid if it is touched at least three times.

6. Moving Averages

Moving averages often provide objective buy and sell signals, hence they should be watched. They show you if an existing trend is still in motion and help confirm a trend change. Do not rely on moving averages to tell you in advance if there is a trend change imminent; use it as a back-up to your chart analysis for trend identification. A combination chart of two moving averages is the most popular way of finding trading signals. Signals are given when the shorter average line crosses the longer. Price crossings above and below a 40-day and 200-day moving average also provide good trading signals. Since moving average chart lines are trend-following indicators, they work best in a trending market.
As can be seen in the EUR/USD 1-hour chart below the 5-period and 25-period moving averages project and confirm the trend in progress. The 5-period moving average crosses over the slower 25-period moving average at 1.2715 confirming the up-trend with an exit point at 1.2770. The same rate 1.2770 is another indication of a resume in the up-trend with an exit at 1.2850.

7. Oscillators

Oscillators help identify overbought and oversold markets. While moving averages offer confirmation of a trending market, oscillators can often warn us in advance that a market has rallied or fallen too far and will soon turn or retrace. Two of the most popular oscillators are the Relative Strength Index or RSI and the Stochastics. Both these oscillators work on a scale of 0 to 100. With the RSI, readings over 70 are overbought while readings below 30 are oversold. The overbought and oversold values for Stochastics are 80 and 20. Oscillator divergences often warn of market turns and as opposed to moving averages they work best in range bound markets. Weekly signals can be used as filters on daily signals. Daily signals can be used as filters for intra-day charts.
As can be seen in the EUR/USD 1-hour chart below, the Stochastics break through the 80-20 barriers and cross over themselves on corrections of the price. This occurs several times.


8. Know the Warning Signs

The Moving Average Convergence Divergence (MACD) indicator combines a moving average crossover system with the overbought/oversold elements of an oscillator. A buy signal occurs when the faster line crosses above the slower and both lines are below zero. A sell signal takes place when the faster line crosses below the slower from above the zero line. Longer-period signals take precedence over shorter-period signals. The MACD histogram plots the difference between the two lines and gives even earlier warnings of trend changes. It's called a histogram because vertical bars are used to show the difference between the two lines on the chart.
As can be seen in the EUR/USD 1-hour chart below, the MACD indicators cross over one another beneath the zero line to show a buy signal and vice versa for the sell signal. This occurs most prominently at 1.2760 to buy, 1.2870 to sell.

9. Trend or Range Bound Market

The Average Directional Movement Index (ADX) line helps determine whether a market is in a trending or range bound phase. It measures the degree of trend or direction in the market. A rising ADX line suggests the presence of a strong trend. A falling ADX line suggests the presence of a trading market and the absence of a trend. A rising ADX line favors moving averages; a falling ADX favors oscillators. By plotting the direction of the ADX line, the trader is able to determine which trading style and which set of indicators are most suitable for the current market environment.

10. Study

Technical analysis is a skill that improves with experience and study. The more you learn and practice the better you'll be, keep studying, fine tune methods, learn what works for you and what doesn't and remain technical and not emotional.